Research Update: Spain's Ratings Lowered To 'A/A-1'; Outlook Negative

Overview

Standard & Poor's is lowering its long-term sovereign credit rating on
the Kingdom of Spain by two notches to 'A' from 'AA-', and its short-term
rating to 'A-1' from 'A-1+'.

The downgrade reflects our opinion of the impact of deepening political,
financial, and monetary problems within the European Economic and
Monetary Union (eurozone), with which Spain is closely integrated.

The downgrade also reflects our view of external financing risks in the
private sector, which we believe could constrain growth and hamper the
government's efforts to narrow the fiscal deficit.

The outlook on the long-term rating is negative.

Rating Action

On Jan. 13, 2012, Standard & Poor's Ratings Services lowered its long- and
short-term sovereign credit ratings on the Kingdom of Spain to 'A/A-1' from
'AA-/A-1+'. At the same time, we removed the ratings from CreditWatch with
negative implications, where they were placed on Dec. 5, 2011. The outlook is
negative.
Our transfer and convertibility (T&C) assessment for Spain, as for all
European Economic and Monetary Union (eurozone) members, is 'AAA', reflecting
Standard & Poor's view that the likelihood of the European Central Bank
restricting nonsovereign access to foreign currency needed for debt service is
extremely low. This reflects the full and open access to foreign currency that
holders of euro currently enjoy and which we expect to remain the case in the
foreseeable future.

Rationale

The downgrade reflects our opinion of the impact of deepening political,
financial, and monetary problems within the eurozone. It also reflects our
view of sustained external financing pressures from the private sector.
The outcomes from the EU summit on Dec. 9, 2011, and subsequent statements
from policymakers lead us to believe that the agreement reached has not
produced a breakthrough of sufficient size and scope to fully address the
eurozone's financial problems. In our opinion, the political agreement does
not supply sufficient additional resources or operational flexibility to
bolster European rescue operations, or extend enough support for those
eurozone sovereigns subjected to heightened market pressures.
We also believe that the agreement is predicated on only a partial recognition
of the source of the crisis: that the current financial turmoil stems
primarily from fiscal profligacy at the periphery of the eurozone. In our
view, however, the financial problems facing the eurozone are as much a
consequence of rising external imbalances and divergences in competitiveness
between the EMU's core and the so-called "periphery." As such, we believe that
a reform process based on a pillar of fiscal austerity alone risks becoming
self-defeating, as domestic demand falls in line with consumers' rising
concerns about job security and disposable incomes, eroding national tax
revenues.
Accordingly, in line with our published sovereign criteria, we have adjusted
downward the political score we assign to the Kingdom of Spain (see "Sovereign
Government Rating Methodology And Assumptions," published on June 30, 2011).
This is a reflection of our view that the effectiveness, stability, and
predictability of European policymaking and political institutions (with which
Spain is closely integrated) have not been as strong as we believe are called
for by the severity of a broadening and deepening financial crisis in the
eurozone.
In addition to our view on the political factors, we lowered the ratings on
Spain because we believe that the country's external financing costs may
remain elevated for an extended period of time owing to its high gross
external financing requirements. These higher costs stem from country-specific
factors, regulatory changes, and an increased home-market bias, in our view.
In particular, we see the following country-specific factors: structural
savings-investment imbalances, high levels of short-term external debt, and
front-loaded amortization requirements in the first half of 2012. Regulatory
changes include prospective increases to bank capital charges for securities
holdings and interbank placements, and uncertainty regarding the effectiveness
of credit default swaps as hedging vehicles (see paragraph 76 of our sovereign
rating criteria "Sovereign Government Rating Methodology And Assumptions").
The ratings on Spain remain supported by our view of its wealthy and
relatively diversified economy, ongoing structural reforms, and moderate,
albeit rising, net general government debt. Moreover, while increased
borrowing costs are likely to cause rising interest outlays, the increase in
the average interest rate on Spain's outstanding government debt, in our view,
has not so far been a material additional burden on its budget.

Outlook

The negative outlook reflects our view that there is at least a one-in-three
chance that we could lower those ratings again in 2012 or 2013. We could lower
the ratings again if:

Additional labor market and other growth-enhancing reforms are delayed or
we consider them to be insufficient to reduce the high unemployment rate;

We see that the government does not undertake additional measures to
broadly meet its budgetary targets in 2012 and 2013 of 4.4% and 3% of
GDP, respectively; or

Further pressure from the private sector leads us to reassess the
sovereign's fiscal performance, particularly if it were to result in an
increased need for additional capital injections from the state or
similar interventions.

Conversely, the ratings could stabilize at the current level if budgetary
targets are met and if risks emanating from contingent liabilities subside.

Related Criteria And Research

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